Executive Summary

Background

This report responds to a request from Senators Joseph Lieberman and John McCain for an estimate of the economic impacts of S. 280, the Climate Stewardship and Innovation Act of 2007. S. 280 would establish a series of caps on greenhouse gas emissions starting in 2012 followed by increasingly stringent caps beginning in 2020, 2030 and 2050. It provides estimates of the effects of S. 280 on energy markets and the economy through 2030, the current time horizon of projections in the Energy Information Administration’s (EIA) Annual Energy Outlook
(AEO2007).

The gases regulated under S. 280 are carbon dioxide, methane, nitrous oxide, and three classes of fluorinated gases—hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride. Covered entities include those in the commercial, industrial, and electric power sectors with annual emissions at any single facility in excess of 10,000 metric tons carbon dioxide equivalent; refiners and importers of petroleum products sold for transportation; and producers and importers of fluorinated gases. EIA estimates that about 78 percent of the total greenhouse gas emissions in 2005 would be covered under the allowance program. The specific S. 280 allowance caps for each time period are:

2012 to 2019. . . . . . . 2004 emissions level
2020 to 2029. . . . . . . 1990 emissions level
2030 to 2049. . . . . . . 22 percent below 1990 emissions level
2050 and beyond . . . .60 percent below 1990 emissions level

Under S. 280, covered entities would be required to report their greenhouse gas emissions annually and submit a matching number of government-issued allowances. Some tradable allowances would be distributed for free and the remainder would be auctioned to raise funds for supporting programs. These include programs to encourage innovative emissions reduction technologies and to mitigate adverse economic impacts on consumers and communities. Allowances in excess of compliance needs can be banked for future use. Entities would also be able to meet up to 30 percent of their allowance obligation with offsets for emissions reductions from non-covered entities and foreign sources.

Results

Analysis Cases

This section discusses the projected impacts of S. 280 relative to a reference case based on the Annual Energy Outlook 2007 (AEO2007).¹ The estimates are sensitive to several assumptions about program implementation that would be made following enactment of S.280. As suggested by Senate staff, the share of allowances auctioned is assumed to grow from 30 percent in 2012 to 90 percent in 2030. Furthermore, although S.280 includes the commercial sector in its coverage list, it is considered exempt for purposes of this analysis because the vast majority of buildings are not large enough to emit 10,000 metric tons of greenhouse gases per year.

The S.280 Core case is the focus of this report. However, because the potential availability and cost of offsets is a significant source of uncertainty in the analysis, the report includes sensitivity cases using a range of alternative assumptions regarding the availability of offsets. The Fixed 30 Percent Offsets case assumes a sufficient supply of economical international offsets is available to allow covered entities to take full advantage of the 30-percent offset option in all years. In contrast, the No International case limits the supply of offsets to domestic sources.

Emissions Impacts and Cap Compliance

Compliance with the caps on covered emissions is achieved through a combination of domestic emissions reductions, increases in domestic biogenic sequestration, purchases of international offsets and the accumulation (crediting) and use (debiting) of banked allowances.

Figure Data

Compared to the reference case, total U.S. greenhouse gas emissions in the S280 Core case are 1,024 million metric tons (13 percent) lower in 2020 and 2,685 million metric tons (28 percent) lower in 2030 (Table ES-1; Figure ES-1).

Emission reductions from energy-related CO2 account for less than half of the total compliance response in the initial phase of the program, when the use of offsets and non-CO2 abatement opportunities predominate. In 2020, the reduction in energy-related CO2 emissions in the S280 Core case, relative to the reference case, accounts for one third of the compliance response. The energy-related CO2 share of the overall compliance response increases over time as the caps (and also the limits on the use of offsets that are directly linked to the cap) are cut, allowance prices rise, and the impacts of investments in new energy related capital accumulate. By 2030, the reduction in energy-related CO2 emissions in the S280 Core case accounts for about half of the total compliance response.

When international offsets are assumed to be more readily available, as in the Fixed 30 Percent Offsets case, covered entities accumulate more allowances in the first phase of S.280 and use those banked allowances to lower the need to reduce emissions through 2030. In contrast, when international offsets are not readily available, as in the No International case, covered entities build a smaller allowance bank and compliance relies more heavily on domestic emissions reductions.

The electric power sector is expected to account for the vast majority of the reductions in energyrelated CO2 emissions. For example, in the S280 Core case, about 89 percent of the energyrelated CO2 emissions reductions in 2030 relative to the reference case are associated with electricity, where substitution away from coal is a relatively cost-effective way to reduce emissions. The remaining reductions in energy-related CO2 are split in roughly equal measure between the industrial and transportation sectors.

Figure Data

Allowance Prices

Energy Price Impacts³

Under S. 280, the value of allowances will generally be reflected in delivered fossil fuel and electricity prices. Higher prices will lead to a reduction in the use of fossil fuels and, where possible, a shift to emission-free or lower-emission energy sources.

Coal prices are most significantly impacted, in both absolute and percentage terms, because coal has the highest carbon content among the fossil fuels and is lowest priced of the fossil fuels. The price of coal to the electric power sector in the S280 Core case is 129 percent above the reference case level in 2020 and 245 percent above it in 2030. Industrial coal users experience similar price impacts.

Natural gas price impacts are much smaller than those for coal. For example the cost of natural gas to the electric power sector in the S280 Core case is 15 percent above the reference case in 2020 and 31 percent above it in 2030. Covered industrial entities that use natural gas face similar impacts. However, natural gas users not covered by the program, including residential and agricultural consumers, benefit from a small decline in their delivered natural gas prices as demand is reduced in covered sectors. The projected natural gas price impacts reflect a massive shift to emission-free technologies for baseload generation, such as nuclear and renewables. If such a transition cannot be made, and conventional coal generation is instead substantially replaced by generation using natural gas, impacts on natural gas prices could increase dramatically.

Average electricity prices in the S.280 Core case are 10 percent higher than the reference case level in 2020 and 21 percent higher in 2030. The percentage change in electricity prices varies across regions, and is closely tied to the share of coal-fired power in the reference case generation mix.

Price increases for petroleum-based transportation fuels in the S280 Core case, relative to the reference case, range from 8 percent to 14 percent in 2020 and from 16 percent to 25 percent in 2030, with jet fuel towards the high end of the ranges and highway fuels towards the low end. Highway fuel prices are less affected in percentage terms because taxes and distribution costs, which are not impacted by allowance costs, account for a larger share of their delivered prices. The increase in the price of gasoline in 2030 is 34 cents per gallon in the S280 Core case.

Energy Use Impacts

When compared to the reference case, the consumption of coal, liquid fuels (mainly petroleum), and natural gas are all lower in the S. 280 cases, while the use of nuclear power and renewable energy are substantially higher.

Total primary energy consumption in 2030 in the S280 Core case is 3 percent lower than in the reference case in 2020 and 6 percent lower in 2030, as conservation and improvements in energy efficiency are stimulated by the higher energy prices and the technology support programs in S. 280. Projected petroleum and natural gas consumption in 2030 in the S280 Core case are higher than present levels, and petroleum use continues to grow throughout the projection.

In contrast, coal use in the S. 280 cases is much lower than in the reference case in all years and lower than current consumption in 2030. To reduce its CO2 emissions, the power industry is expected to shift away from its historical reliance on coal generation. In the reference case, coal accounts for 58 percent of total generation in 2030,⁴ but its share falls to between 11 percent and 35 percent in the main S. 280 cases. Coal generation in the S280 Core case is 26 percent below the reference case level in 2020 and 69 percent lower in 2030. Relative to the 2005 level, coal generation in the S280 Core case is 48 percent lower in 2030.

An estimated 145 gigawatts of new nuclear capacity is added in the S280 Core case, increasing nuclear generation to 1,909 billion kilowatthours in 2030, 120 percent above the reference case level in 2030. Across the three main S. 280 cases, nuclear generation in 2030 provides from 22 percent to 42 percent of total electricity generation, compared to 15 percent in the reference case.

The renewable share of power sector generation in 2030 is 9 percent in the reference case, and grows to between 22 percent and 28 percent across the main S. 280 cases. In the reference case, biomass generation grows from 38 billion kilowatthours in 2005 to 111 billion kilowatthours in 2020 and 131 billion kilowatthours in 2030. In the S280 Core case, biomass generation in 2020 is over three times that of the reference case, and by 2030 is almost 8 times greater than the reference level. Wind generation grows from 15 billion kilowatthours in 2005 to 51 billion kilowatthours in 2020 and remains at that level through 2030 in the reference case. In the S280 Core case, wind generation in 2020 is nearly double that of the reference case, and by 2030 is 2.5 times greater than the reference level.

The adoption of carbon capture and storage (CCS) technology for electric power plants is not expected to be cost-competitive with nuclear and biomass for base load generation at the allowance prices in the S280 Core case. In the No International case, with higher allowance prices, coal plants with CCS begin to penetrate in the last few years of the projection, and 11 gigawatts of capacity with CCS are added by 2030. In a sensitivity case where nuclear capacity is held to its reference case level, CCS plays a larger role by 2030. However, CCS technology also faces significant potential hurdles, and its availability for commercial deployment on a large scale prior to 2030 is uncertain.

In transportation, the energy price increases under S. 280 reduce the projected energy consumption by influencing vehicle purchase and travel decisions. By 2030, transportation use of motor gasoline declines by 4 percent in the S. 280 Core case relative to the reference case. With a shift in the vehicle mix, including increased sales of hybrid and diesel vehicles, and the adoption of more advanced technologies, new light vehicle fuel economy improves by 2 to 3 percent by 2030 (0.6 to 1.0 miles per gallon) in the main S. 280 cases, compared to the reference case.

In the industrial sector, total delivered energy is lower by 2 percent in the S280 Core case in 2020 compared to the reference, and 6 percent lower in 2030, partly due to slower growth in output of energy-intensive industries as a result of higher energy costs. Among these industries with large percentage reductions in energy use relative to the reference in 2030 are aluminum (10 percent), steel (10 percent), and glass (8 percent).

Specific industries could be more heavily impacted than the overall industrial sector. For example, in the reference case, an emerging coal-to-liquids (CTL) industry is projected to supply 434 thousand barrels of oil per day by 2030. Under S. 280, the CTL is not expected to be viable in the 2030 time frame, eliminating this domestic source of petroleum supply, and reducing projected industrial coal consumption for CTL heat and power by 0.9 quadrillion Btu.

Economic Impacts

S. 280 increases the cost of using energy, which reduces real economic output, reduces purchasing power, and lowers aggregate demand for goods and services. The result is that projected real Gross Domestic Produce (GDP) falls relative to the reference case. The impacts generally increase over time, as the cap-and-trade program requires larger changes in the energy system. Relative to the reference case, real GDP in 2030 is between 0.3 percent and 0.5 percent lower in 2030 in the main S. 280 policy cases. Impacts on real consumption, a more direct indicator of the economic welfare of American consumers, are similar, averaging 0.4 percent lower in the main S.280 policy cases.

Total discounted GDP over the 2009 to 2030 time period is $533 billion (-0.22 percent) lower in the S280 Core case and ranges from $471 billion (-0.19 percent) lower in the Fixed 30 Percent Offsets case to $572 billion (-0.23 percent) lower in the No International case.

The combined value of the auctioned and distributed allowances, or allowance revenue, tends to grow over time as the allowance price rises. By 2029, the total revenue in the S280 Core case rises to $287 billion, before falling to $233 billion in 2030 when the number of allowances issued drops. Economic impacts are sensitive to the specific assumptions made regarding the recycling of allowance revenues.

Uncertainty

The prospect for substantial reductions in the role of conventional coal-fired generation by 2030 and the potential role of international offsets are among the most important uncertainties affecting the analysis.

This analysis suggests that increasing the use of nuclear and renewable power is an economical compliance strategy, with nuclear generating capacity more than doubling over the next 25 years. However, concerns about siting, waste disposal, and project risk could deter nuclear development. The No Nuclear case holds nuclear capacity to the reference case level, driving allowance prices 6 percent higher than those in the S280 Core case by 2030. Similarly, there are questions about the potential development of a large scale bio-power industry. For example, the analysis does not assume enactment of a significant new mandate for the use of biofuels in the transportation sector, which would tend to reduce the availability of biomass for electricity generation. The costs of integrating large quantities of wind into the power grid are another issue. If nuclear and renewable generation cannot grow rapidly, the deployment of CCS technology would be more likely. However, the industry would again be relying on a technology about which there is considerable uncertainty.

The effects uncertainty regarding the potential role of international offsets is illustrated by the range of allowance prices, an indicator of marginal compliance costs, across cases with different assumptions about offset availability. Relative to the S.280 Core case, allowance prices in 2030 are 20 percent higher in the No International case and 35 percent lower in the Fixed 30 Percent Offsets case.

While the report includes some sensitivity analysis of individual uncertainties, projected allowance prices and economic impacts could increase well beyond the estimates provided if issues arise simultaneously in several key areas. Moreover, the likelihood of such a scenario may not be independent of policy design choices that influence the behavior of stakeholders. For example, a stakeholder with a primary focus on GHG emissions reduction and a secondary interest in minimizing reliance on nuclear power and offsets would likely be less inclined to actively oppose both nuclear power and offsets if the policy design included a mechanism to relieve compliance pressure that was tied to the level of compliance costs or other measures of economic impact.

The analysis of S. 280 is subject to a number of additional limitations that deserve emphasis. S. 280 calls for a reduction in the emission caps in 2030 and 2050, but the modeled time horizon in this study extends through 2030. While EIA has attempted to take into account investor behavior anticipating the post-2030 regulations, such as advanced allowance banking, the economic implications of S.280 on the economy after 2030 have not been evaluated. Our analysis suggests that large reductions in carbon dioxide emissions in the electric power sector will be necessary to achieve the emissions caps through 2030. Meeting the 2050 caps would likely require a nearly carbon-free electric power supply and a substitution of petroleum-based fuels in transportation, a potentially costly transition from current trends.

The reference case used as the baseline for this analysis is only one of many possible paths representing future economic and energy markets trends under current laws and policies. The Annual Energy Outlook 2007 presents a range of cases reflecting alternative growth and price paths. All else equal, higher growth in the U.S. economy raises baseline emissions and increases the total amount of reductions required to comply with a cap linked to historical emissions, while lower growth has the opposite effect. Assuming fixed emissions objectives for other countries, higher growth abroad would increase their internal requirement for emissions reductions and reduce the availability of international offsets to U.S. entities covered under S.280, while lower growth has the opposite effect. A baseline with higher conventional energy prices tends to increase both energy efficiency and the penetration of alternative energy sources, reducing the burden of compliance with a cap linked to historical emissions, while lower prices have the opposite effect.

Executive Summary Table

Notes and Sources